#170 Restraint of Trade Clauses in Employment Contracts - Can You Have Them?
In today's episode, we're exploring one of the most complex and controversial issues in employment law: restraint of trade clauses in employment contracts. I'm diving into this because in the small business circles in which I operate, there's a lot of discussion around whether or not restraint clauses are valid and whether we can have them.
It has also become more topical in the broader community due to a recent decision in the United States, where the Federal Trade Commission made a ruling banning the use of restraint of trade clauses in contracts altogether. The question we’re now asking ourselves now is: will Australia follow suit?
Restraint Clauses: What Are They and Are They Enforceable?
Restraint of trade clauses are designed to prevent former employees from competing with their ex-employer in ways that could harm the business. These clauses come in two main types: non-compete and non-solicit. A non-compete clause restricts an employee from working in a similar business, while a non-solicit clause prevents them from contacting the former employer's clients. The million-dollar question here is whether these clauses are enforceable. The simple answer? Only if they are reasonable. I’ll take you through the nuances of what our legal system deems a restraint clause enforceable or not.
Tailoring Clauses to Your Business Needs
One of the most common mistakes I see is the use of broad, generic restraint clauses that cover large geographical areas and long periods. These are often unenforceable from the get-go. Business owners need to draft these clauses to fit their specific needs. We’ll discuss how to make sure your restraint clauses are not so broad that they prevent an employee from earning a living, as the courts heavily scrutinise such clauses.
Practical Steps to Protect Your Business
Rather than relying solely on restraint clauses, I recommend bolstering other areas of your employment contracts to safeguard your business. By being proactive and understanding what is reasonable for your specific business, you can better protect your interests and avoid the high costs and stress associated with any legal battles that may arise.
If you're a small business owner or planning to hire employees, this episode is a must-listen to ensure you're setting yourself up for success while staying on the right side of the law.
Full Transcript:
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[00:00:00]
Tracey: In today's episode, I'm going to deep dive into a really complex and controversial employment law issue. And that is the issue around restraint of trade clauses in employment contracts. I'm diving into this because in the small business circles that I operate, there's a lot of discussion around whether or not restraint clauses are valid and whether we can have them.
It's become more topical in the broader community because of a recent decision in the United States. Recently, the Federal Trade Commission made a ruling banning the use of restraint of trade clauses in contracts altogether So the discussion [00:01:00] is around whether or not Australia are going to follow suit.
It's far too early to tell, but the consensus is that Australia is likely to follow suit to some extent. It's worth noting, quickly, that late last year, the treasurer announced a review, it was the competition review, it was announced in August last year, and it included. a review of the use of restraint clauses in employment contracts. And an issues paper was released earlier this year, in April this year, and it noted the growing concern around the use of these clauses, citing the negative impact on job mobility, innovation, and wages growth.
So there's several layers of scrutiny going on at the moment that include considering whether restraint of trade clauses should be used. So, What does this mean for small businesses and why is it important? And that's what I want to share in today's [00:02:00] episode. I act for small business owners. You know that, and if you're a long time listener, you know that my passion area is supporting coaches, creatives, and consultants setting themselves up properly so they don't need to call a lawyer like me later when things go wrong.
Understanding employment agreements, what you can and can't do to protect your business is all part of that setting yourself up properly. So you've heard me say time and time again, prevention is better than cure in business. And this episode leans into that because we need to know what we can and can't include in our employment contract as small business owners so we know what it is that we can and can't do to legitimately protect our business. So.
Let's dive in to what is a restraint clause in an employment contract. A restraint of trade clause is a clause in an employment contract that is designed to prevent an employee from working in a business a [00:03:00] similar business in a particular way that could affect the previous employer's business. That's what it is. That's the overarching high level definition of what it is and what it's for.
There are two main types that we'll see in employment contracts, non compete clauses and non solicit clauses. As you would expect, the non compete clause seeks to prevent the employee from working in a similar business, under certain circumstances. The non solicit clause allows the employee to work in a similar business but seeks to prevent the employee from contacting clients of the former employer to try to attract those clients away.
And that can extend to soliciting co workers, suppliers, referral partners, other parties that have key relationships with that former employer. So the million dollar question here, when we're looking at these clauses, is can we have them? Are they [00:04:00] enforceable? And that's the question that business owners need to be considering when they are wanting to include restraint of trade clauses in an employment agreement.
I should just say that the reference to employment agreement and employment contract interchangeable, it's the exact same thing. The answer to the question, are they enforceable is only if they're reasonable. So the way the law works at the moment is that it will deem a restraint of trade clause unenforceable, unless it is reasonable to protect the legitimate interests of the business.
There is a lot of case law in this country that goes to establishing what is reasonable to protect the legitimate interests of the business. So just because a business owner wants it or thinks it's important doesn't mean it's valid. And just because there's a clause in a contract that both parties have signed does not automatically mean that clause [00:05:00] is going to be valid and enforceable.
If it's challenged, the law's entitled to look at it and consider whether or not it is in fact enforceable. So you need to keep that in mind. Just because you want to doesn't mean you can.
What I see a lot of is blanket stock standard, restraint of trade, really large geographical areas for really long periods of time, and then some employers who use templates will have cascading, so they'll say you can't work for an employer in all of Australia, or in all of New South Wales, or in all of Sydney, or within five kilometers.
My view is get it right in the first place. Know what you're doing and you don't need that. Then we look at the timeframes for two years, or for 12 months, or for six months. Again, get it right.
Legal documents are challenged all the time, and that's why business owners need to be absolutely certain that they have taken the time to ensure that their legals have been developed for their business. They've been drafted properly for their [00:06:00] business, their own unique business, because no two businesses are the same, and that the clauses included in their legal documents are valid and enforceable.
The point of having legals in place, and this includes your employment contracts, is to protect the business down the track if something goes wrong and the document is challenged. There is no point closing your eyes, hoping for the best, thinking it won't happen to you and then waiting. There is no point having something in place that you are not confident works for your business that you just don't know. To that I say, flip it, take the steps to know, take the steps to understand. So when we're talking about employment contracts, dive in and understand what is reasonable in a restrictive trade clause in your employment agreements for your business. What is reasonable?
Know what is reasonable, have something drafted accordingly. So let's look at some of the things that the court will consider when it's looking at a clause like this to determine whether it's [00:07:00] reasonable. The first question that will be asked is, is the employer seeking to protect the legitimate interests of the business?
So we'll take into account the type of business, the industry, the services being provided, the relationship developed with clients by that employee, confidential processes, knowledge, know how, confidential information, all the things. What is the employee exposed to? What do they have access to? What are they really entrenched in?
The law will look at the length of the restraint period. I mean, generally speaking, a reasonable restraint clause is only needed for a few months, have a think about what it is that the restraint clause is trying to do, and then what can the business do after an employee leaves to protect itself? Look at the length of the restraint period.
If it's 12 months or longer, chances are straight out of the gate. Unenforceable, unreasonable. The court will look at individual criteria on a case by case basis. [00:08:00] Like, well, how long was the employee employed? What was the employee's role?
What's the purpose of the restraint clause? What literally, is the restraint clause actually trying to protect against? This is why I say these blank clauses don't serve anybody because they're not specific and they're not tailored.
The other thing to say here, which is a really important question is, is the restraint clause so broad that it has the effect of stopping the employee from earning a living? That is not the intention of allowable restraint provisions and employer simply cannot stop someone from earning a living.
So that's why I say it needs to be assessed on a case by case basis. So you can see there's nuancing here and there's no black and white. There's no one size fits all approach that you can apply to a whole host of businesses. It doesn't work like that. Let's take an example to give context, a really simple example of a hairdressing business.[00:09:00]
And these types of matters have been before the courts and there's case law on this. But if we're talking about a hairdressing business and we're talking about a senior hairdresser that is front and center with clients, has been with the employer for a very long time, has developed close relationships with clients. That employee leaves and there's a restraint clause.
What's going to be reasonable? The way the courts will look at this is, well, let's have a look at the industry and the nature of the business. So yes, employees generally do have close personal relationships with the clients when they're providing the service. Hairdressing clients will rebook a couple of months in advance, usually, and they will continue to want the same hairdresser or stylist generally.
So what is a reasonable restraint clause then to protect that business if that employee leaves? The way the courts will look at this is to say, well, probably three months or around that, something like that, because that's the time it's going to take for an employer to be able to nurture that [00:10:00] relationship with that client, break that bond with the former employee and provide stellar services to those clients by somebody else.
Three months, six months, something like that. But if you're looking at a 12 month ban or 12 month restraint to stop that former employee from working in a similar business nearby, that's not going to hold because the business doesn't reasonably need 12 months to be able to nurture its relationships with its clients when we're looking at a couple of months of a revolving door here, when clients come in. So that's the type of thing that we need to be considering. What is it that the business can do to protect itself? And there's a lot, there's a lot of business can do to protect itself from losing clients and nurturing those relationships. This is really important, particularly when we're talking about the clients that I work with, coaches, creatives, and consultants in this personal service area, there's a lot that can be done and it needs to be done. Employers need to be proactive when an employee leaves for whatever reason to take proactive steps to protect its business, rather than [00:11:00] simply sitting back and relying on a restraint clause and hoping for the best.
A more complex example would be a high level employee. So if we're talking a consulting or personal services business, say a law firm with high level employee, senior employee, really high salary is across all the ins and outs of how the business work has access to all the clients, knows intimately all the details of the matters, has a really broad reach across the team and exposure to all the confidential information in the business. Restraint's going to be really important if that employee leaves because the business needs to be able to protect itself from losing those clients and from that really senior level employee going to another firm and sharing that detail.
So you can see where this is leading, but I'm going to come back to things to do moving forward. But first I just want to touch quickly on enforcement. So we've talked about restraint of trade clauses. We've talked about why they're topical and [00:12:00] controversial. We've talked about the need to make sure they're tailored for your business, for your small business, you need to make sure they're tailored because there's no one size fits all. And we need to dive in and assess what is reasonable for your business and for the particular employer employee relationships that the contract applies to.
So that's important. And we know that, but let me just share with you what it looks like to seek to enforce a restraint of trade clause. So legal proceedings can be commenced by an employee who has left who wants to challenge the reasonableness or otherwise of a restraint of trade clause and they can commence legal proceedings to have those clauses set aside if they think it's too broad or far reaching. An employer can commence legal proceedings to enforce restraint clauses, but there first needs to be evidence of a breach of the restraint clause. The employer needs to be able to establish that the clause in place is necessary to protect the legitimate interests of the business.
It has to be fair. And the employer needs [00:13:00] to be able to establish loss or damage or likely loss or damage if the employee continues to breach that restraint clause. There's a lot of work here on both sides. It's time consuming, it's expensive, it's serious. So there needs to be financial resources to be able to commence those proceedings, to seek to enforce or challenge a restraint clause.
This is not for the faint hearted.
To avoid getting to that point, we want to make sure that we're setting ourselves up for success as small business owners, because you might be listening to this and thinking, Oh, gosh, Tracey, I'm never going to enforce it. That's just not what I want to do. I'm not that sort of person. I can't handle conflict.
I don't have the money. I would never spend many, many, many, many thousands of dollars, tens of thousands of dollars potentially to enforce it. So what's the point. The point is to manage the rights and obligations and expectations of the parties in entering into an agreement. So what I say is [00:14:00] rather than drafting in simply a restraint of trade clause and hoping for the best, give time and attention to your confidentiality clauses. Make sure you develop in your agreement, solid confidentiality clauses. Take care to address your intellectual property. Make it absolutely clear what the business asserts ownership over and what the employee can and cannot do with any intellectual property that's developed in the course of this employment relationship.
Deal with what information is to be returned upon termination. Make it really clear what processes and systems are in place to deal with monitoring who has access to what information in the business. Have checks and balances in place to make sure you know who's accessing information from time to time.
And have checks and balances in place to guard your IP and your templates. If you've got internal working templates that you use within your business, have a way to know if that's being accessed unlawfully, have a [00:15:00] way to know if people are downloading this and emailing it to themselves. What email accounts do your team use?
What do they have access to and do your team only have access to the information and material in your business that they actually need to do their job? Those are some safeguards. Those are some things to start thinking about in your business to help protect against issues if and when an employee leaves. What I'm really saying here is, as a business owner, keep your finger on the pulse with what is going on in your business.
At the end of the day, the clients are clients of your business, and you have the right to ensure you are active in those client relationships so that you are less exposed if an employee leaves and you're not coming in cold to start talking to clients of whom the employee had full access to.
So my view is that there is likely to be some type of regulation [00:16:00] around restraint clauses in our employment agreements. It's likely coming. The extent of that reach, it's too early to tell, but there's likely to be something put in place where business owners are restricted on what they can do with their restraint of trade clauses.
That's my view. So to that, I say, let's be proactive. As always, prevention is better than cure. We don't need to sit around and wait. What we should be doing as business owners is taking proactive steps to ensure that our employment agreements are strengthened and that the protection for our business is strengthened around other clauses such as confidentiality and intellectual property provisions that can help achieve that peace of mind that we want as small business owners when we're growing our team.
It's hard enough as it is running a business, growing a team, finding the right people, all the things to then have to worry about safeguarding should something go wrong or should someone leave is a lot. It doesn't have to be overwhelming. [00:17:00] So what I'm saying here is this is topical. You need to know this. Be aware of this.
There is work to do here with your employment contracts because it's not a stock standard, throw out a template, get them to sign it and she'll be right. It's just not that. And I've now shared some really important reasons why this is the case. The other thing I want to say here is make sure you're getting your legal advice on these issues from your lawyer.
If you need HR advice, go to your HR specialist. Don't go to your friend down the road. Don't take your legal advice from your business coach. I see it too many times when, despite the best of intentions, the wrong advice is given and business owners end up in a position of weakness. They end up being exposed with not a leg to stand on when they're in a situation where the employee or former employee has done the wrong thing.
Don't let that be your business. I am so happy to talk to you about this. You can tell I love talking about these types of things, which is why I share this type of content on the podcast. [00:18:00] If this is resonating, if you're worried, if you think now's the time to get empowered, Tracey, I'm going to flip this.
I'm going to take steps to make sure that we're protected. Reach out. The links are all in the show notes. Reach out, book a time to chat. We can have the conversation. Let's talk about what you've got in place. Let's have a look at what it is. If you don't have anything in place, that's okay. Let's get something really aligned and really solid in place to protect your business.
You can't afford not to with this stuff. hope you found this episode valuable. You know I love delivering the podcast and I'm so grateful for your time. Thank you so much for joining me. I'll catch you next time.
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